Pancreatic islet transplantation is the most effective treatment for type 1 diabetes, but the shortage of donor islets and risk of immunological rejection prevent it from being used widely. Mesenchymal stem cells in the Wharton's jelly of human umbilical cords are accepted as a promising alternative transplant source. The current method of inducing differentiation is time consuming. The aim of this study was to develop a novel method combining genetic and chemical approaches to tackle this problem and minimize the potential risk of rejection. Freshly isolated and expanded human umbilical cord mesenchymal stem cells (HUMSCs) were induced to differentiate into insulin-producing cells by the novel two-step method. In this method, HUMSCs were first transfected with neuronal differentiation 1 (NEUROD1) for 2 days and afterwards treated with chemical agents for 8 days to induce differentiation. The differentiated cells expressed the pancreatic cell markers, which were pancreatic and duodenal homeobox 1 (PDX1), glucagon, insulin, and NK2 homeobox 2 (NKX2-2), and released insulin both spontaneously and after high-glucose stimulation. Then, differentiated cells were transplanted via tail vein into a diabetic rat model induced by streptozotocin. Hyperglycemia, body weight and survival rate of the rats was improved, and serum insulin levels increased after transplantation. More importantly, it was histologically confirmed that transplanted cells homing to the pancreatic gland of diabetic rats and improved the morphology of pancreatic islets of the recipient rats. Overall, the novel two-step method successfully induced HUMSCs to differentiate into insulin-producing cells and effectively treat the diabetic rat via vascular delivery.